Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 64-91

1964-1 C.B. 219

Full Text

Rev. Rul. 64-91 /1/

In Revenue Ruling 16, C.B. 1953-1, 173, the Internal Revenue Service stated its position concerning the treatment of ad valorem property taxes on mineral-bearing lands for purposes of computing the depletable gross income of the lessor and the lessee where, pursuant to the terms of the mineral lease, the lessee pays all such taxes which are imposed on the leased lands.

The typical lease dealt with in that Revenue Ruling provided for royalty payments to the lessor by the lessee based upon the amount of ore mined during the year, subject to minimum annual payments creditable against future production to the extent that the minimum payments were in excess of royalties based upon production during the year. The typical lease also required the lessee to pay all ad valorem property taxes accruing on the property during the period the lease remains in force. It was held that the taxes in question should be allocated between lessor and lessee in proportion to the values of their respective interests in the property and that amounts paid as the lessor's share of such taxes were to be treated as additional royalties which are excludable from the lessee's gross income and includible in the lessor's depletable gross income to the extent that there is sufficient gross income from mineral production to cover the tax. It was further held that such amounts should be treated as delay rental, a deductible expense of the lessee and nondepletable income to the lessor, if there is insufficient gross income from production to cover the tax.

The Service position that the property taxes in question should be allocated between lessor and lessee was rejected by the United States Court of Claims in Wellington R. Burt v. United States, 170 Fed. Supp. 953 (1959). The Burt decision was followed by the Tax Court of the United States in Winifred E. Higgins v. Commissioner, 33 T.C. 161 (1959). In both of those cases there was sufficient income from production to cover the amounts of Minnesota ad valorem taxes paid by lessees under iron ore mining leases containing provisions similar to those summarized above, and the court decided that the entire amount of such taxes involved in each case represented additional royalty income to the lessor on which the lessor was entitled to the depletion allowance.

The Service now considers that the wrong issue was presented for decision in the Burt case in that it was conceded that the lessor in that case was entitled to treat a portion of the ad valorem taxes paid by the lessee as gross income from the property subject to the depletion allowance and the case was defended on the basis of the allocation rule provided for in Revenue Ruling 16. Upon further consideration, the Service now agrees with the rejection of the Revenue Ruling 16 position that there should be such an allocation. It is further considered that whether a lessee's undertaking to pay ad valorem taxes should be treated as constituting a part of the arrangement between the parties for the sharing of gross income from production should not depend, as was indicated in Revenue Ruling 16, upon whether the production income at any particular time is or is not sufficient to cover ad valorem taxes paid by the lessee.

Lessors and lessees are known to be taking opposite positions as to whether a lessee's undertaking to pay ad valorem taxes under the type of lease here in question represents a part of the arrangement between the parties for the sharing of gross income from production. Under the circumstances, pending judicial clarification of the controlling criteria the Service has no alternative but to continue to litigate what is essentially an issue between the two parties to such a lease.

In view of the foregoing, Revenue Ruling 16, C.B. 1953-1, 173, is revoked, as is Revenue Ruling 54-600, C.B. 1954-2, 164, which amplified Revenue Ruling 16 in certain respects. G.C.M. 26526, C.B. 1950-2, 40, which dealt similarly with ad valorem property taxes paid by a lessee of oil and gas wells, is also revoked.

Since the interest of the Service lies solely in preventing the allowance of percentage depletion to both lessors and lessees in respect of the same amounts of gross income from the property leased, the Service is prepared, pending resolution of the issue in the courts, to dispose of this issue in pending cases in which both lessor and lessee are in agreement as to the division of the gross production income between themselves and will enter into closing agreements satisfactory to the Service pursuant to section 7121 of the Internal Revenue Code of 1954 based upon such agreed division. The allocation formula provided for in Revenue Ruling 16 may be utilized for this purpose. However, other methods agreed upon by the lessor and lessee for treating the ad valorem tax in relation to the sharing of gross production income will be considered if submitted as a basis for closing.

In preparing future income tax returns pending resolution of the issue in the courts, taxpayers may continue to compute percentage depletion as affected by this issue in the same manner as computed in returns already filed. Deductions so computed will be subject to adjustment through the allowance of claims for refund or the collection of deficiencies in tax at an appropriate future time.

/1/ Also released as Technical Information Release 549, dated Mar. 9, 1964.